A key question on the ‘millionaires tax’: What makes you a millionaire?

Much of the debate over Question 1 on November’s ballot — which would add an extra 4 percent tax on incomes over $1 million — hinges on what income gets counted and how.

Cranberry farmer Leo Cakounes, who stars in a TV ad opposing Question 1, which would amend the Massachusetts flat 5 percent state income tax to add a surcharge on the highest earners.John Tlumacki/Globe Staff

Can I still put my house on the market? Will this wipe out my nest egg? What about selling my business?

These are the sort of questions going through the minds of Massachusetts voters when faced with a measure on November’s ballot known as the “millionaires tax” or “Fair Share” amendment. The premise of Question 1 is simple: Should Massachusetts amend its flat 5 percent state income tax to add a surcharge on the highest earners, with the proceeds designated for education and transportation?

If passed, here’s how Question 1 would affect taxpayers: People who earn more than $1 million in a year would pay the current 5 percent tax on the first $1 million, then 9 percent on all income above that. For a household that earns $1.5 million, their current $75,000 tax bill would grow to $95,000 — 5 percent on the first $1 million, or $50,000, plus 9 percent on the remaining $500,000, or $45,000 more. (See our calculator below to figure out the levy on your taxable income.)

That’s easy enough, right? Except for one key question: What exactly counts as income?

This is where things can get complicated, tax experts say. To be clear: Question 1 does not affect what is taxed. Salaries, some retirement fund withdrawals, and gains on property sales are all treated as income now and would remain so if Question 1 passes.

But confusion can arise from “understanding how you get from what your net worth is, compared to what your actual taxable income is each year,” said Meg Wiehe, the former deputy executive director of the Institute on Taxation and Economic Policy, who has been working with the Massachusetts Budget and Policy Center, a think tank that supports Question 1.

“There are people who are fabulously wealthy — we’re talking tens, twenty million, a hundred million dollars of net worth — who very likely may have taxable income of less than a million dollars a year,” she said.

How is this possible? To explain, we’ve put together a breakdown of major income categories, how they’re taxed, and how they fit into the world of Question 1.

Salaries/wages

This one is easy: “No exceptions. That is all taxed,” Wiehe said. For most working-age adults, wages are our primary source of income. But of the households that had incomes higher than $1 million in 2019, only about a third of that income came from salaries or paychecks, according to a report from Tufts University’s Center for State Policy Analysis.

Retirement income

How about retirees with a large 401(k)?

Massachusetts taxes only the income you take out of your retirement account each year, not the amount in the account itself. In other words: If your only income is withdrawals from retirement savings, Question 1 would apply only if you’re taking out more than $1 million a year.

Another note: Social Security income is never taxed in Massachusetts, and withdrawals from many government pensions and Roth IRAs are generally not taxed. Withdrawals from private employer pensions, like a 401(k) or a 401(a), and portions of traditional IRAs are typically taxed.

Retirees would potentially get hit by the surtax if their total income is more than $1 million, perhaps as a result of a combination of retirement withdrawals, plus profits from the sale of a house or a business. More on this later.

The vast majority of taxpayers don’t need to worry about their nest egg — less than 1 percent of older Massachusetts taxpayers have enough annual income to qualify for the surtax, according to a report by Mass Budget. Even people with sizable retirement savings — say, $5 million — are unlikely to face higher taxes, since “literally no one is going to take all of the money out of their retirement account in any given year,” Wiehe said.

Property sales

This is where things get more complicated, and where many of the people likely to pay the “millionaires tax” will trip the $1 million threshold.

When you sell a home, business, or stock, you’re taxed not on the sale price of that asset, but on the capital gain — in other words, the profit.

Take selling your house — a common concern in a state where homes routinely sell for prices north of $1 million. When you sell your primary residence, you’re taxed on the capital gain: That is the sale price minus what you originally paid for the house, any capital improvements you made that increased its value, and some fees associated with selling, plus an exemption of $250,000 if you’re single or $500,000 if you’re married.

Let’s say you and your spouse sell your longtime home for $1.6 million. If you originally bought the house for $600,000, you profited $1 million, right? Not for tax purposes. The exemption alone would knock your taxable income down to $500,000, without factoring in any additional deductions from improvements or broker fees. As long as your other income doesn’t bring you back above the $1 million threshold, you’d pay only the flat 5 percent tax rate.

But if you earn more — say, an additional $600,000 between salaries and other sources — your total taxable income would be $1.1 million, and your state tax bill would climb from $55,000 today to $59,000 under Question 1.

Only 2 percent of home sales in the state produced a capital gain of more than $1 million in 2021, according to Mass Budget. In Boston, 212 home sales notched this dollar amount in 2021.

What does this mean for me?

In the end, very few households earn more than $1 million a year in taxable income. In 2019, only about 21,000 Massachusetts taxpayers, or less than 1 percent of all households, had incomes higher than $1 million, according to the Tufts report.

Still, for some of those who do, the surtax could mean a sizable tax hike, according to an analysis done by the state executive office of administration and finance.

The state also estimates the proposed surtax could increase revenues by $1.2 billion a year, which is about 2.4 percent of the current annual budget. The state, however, also warns that the surtax revenue “will vary significantly and unpredictably from year to year.”

Financial experts agree that if Question 1 passes, there will be people who use various tactics to avoid the surtax, potentially moving themselves or their businesses out of Massachusetts to avoid it. Another potential loophole? Married couples that file separate returns as a tactic used to avoid the extra tax. A couple with a combined $1.5 million in taxable income could potentially file separately as having $750,000 each, staying below the $1 million threshold and saving $20,000 in taxes under Question 1.

Someone who sells their business may minimize the surtax’s impact by structuring the deal to take payments over multiple years. Others may consider setting up a donor-advised fund, which reduces their tax liability while giving money to their favorite charities.

Per the Tufts report, about half of the American households that earned more than $1 million a year from 1999-2007 were so-called one-time millionaires — people who had a significant windfall one year as a result of selling a home, business, or long-term investment.

Laura O’Brien, a tax partner at LGA, LLP in Woburn and Chestnut Hill, said these one-timers are the people who may have the best shot at blunting the impact of the extra levy.

”There are going to be planning opportunities in some cases,” O’Brien said. “If your W2 is well over a million dollars, how can you really plan for that? Your earnings are your earnings. I think the planning is going to come for those one-times.”